2013 Fixed Income Strategy

7/29/2019 2013 Fixed Income Strategy

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FIxEd INCOmEmARKET STRATEgy

Wot gt Foo a mo of m FvotTh (o) fo 2013

J A N u A R y 2 0 1 3

Hhht} Wont Get Fooled Againand More of My Favorite Theme (Songs) for 2013. In the

irst o our reatest hits thees or 2013, over the lon run toas low interest

rates lock in neative returns ater inlation, oolin investors epectin air

returns in ie incoe. However, the short-run return outlook epens criticall

on the net phase o ebt ceilin-inuce uncertaint. Whether that outcoe

erails the econoic recover will eterine whether rates en up hiher or lower

b ears en, an whether our epectations or oest increases in interest rates

in 2013taretin 2.25% or the 10-ear Treasureans we en up oole aain.

} Like a Rolling Loan. How oes it eel? The ouble-iit returns o the hih iel

arket over the past ear elt prett oo. But lower startin iels eans

lowerin asset class return projections in 2013 to i to hih sinle iits. We

sta overweiht hih iel as those returns, while lower than in past ears, are

still attractive or the eault risk that aple lobal liquiit keeps at ba in 2013.

} The Way We Were. Whats too painul to reeber, we sipl choose to oret

At the root o the last creit crisis stoo overl accooative onetar polic

uelin asset price bubbles. Have policakers learne an lessons? Persistent

accooative onetar polic reains the ke eterinant o risk asset

price perorance in 2013. That shoul ake risk assetsstocks an the

ost creit-sensitive bonsthe best perorin asset classes in 2013.

} Movin Out. O the baseent, that is; representin our housin recover thee

an a source o optiis to the econoic outlook in 2013. The trouble is that

optiis is share b everone else. Housin recover-thee investent

strateies alrea outperore in 2012; we look or lower returns in 2013

an unerperorance o hoebuiler vs. bank stocks as banks reain a

stanout beneiciar not ull price. We also look or outperorance ro

bank bons an ortae creit, albeit to a lower eree than last ear.

} How Will I Know? Just trust our eelins When it coes to the ipact China

has on the lobal econoic outlook, probabl better to i eeper. The loner-

run China outlook epens criticall on the abilit o the new leaership to

ipleent ke structural reors. For 2013 however, China likel supports the

lobal rowth outlook, uelin continue stron eerin arket perorance.

} Turning Japanese. Or shoul we sa Turnin Bernankese? Japan takes a pae out

o the Fe plabook an a inall successull relate. Thouh now consensus

viewpoints, a weaker en uels a stroner Japan equit arket in 2013.

Jff rob, manain director,

is BlackRocks Chie Investent

Strateist or Fie Incoe

BOnd markeT summary

sto

poto

2012Tot

rt(%)

yTm of

12/31/12(%)

2013FtTot

rt(%)

Hih yiel

Overweiht 15.81 6.13 58

Bank LoansOverweiht

10.51 5.59 4.50

Securitize

Assets*Overweiht

2.94 2.13 23.5

Aenc

mortaesUnerweiht

2.59 2.22 1.75

CorporatesNeutral

9.82 2.72 22.5

Non-US

dollarNeutral

4.09 1.64 2.80

Eerin

marketsOverweiht

17.44 4.38 59

Ination

ProtectionUnerweiht1

6.98 1.51 0.75

Treasur/

AencUnerweiht

1.99 0.86

-0.75

1.8

reFerence indices (decemBer)

sto

2012Tot

rt(%)

yTm of

12/31/12(%)

2013FtTot

rt(%)

US Areate 4.21 1.74 12

municipal Bon 6.78 2.17 2.25

* As of 12/31/2012, Securitized Asset breakdown: ABS (YTD 3.66%, 2013 Forecast 1.35%, Neutral), CMBS ( YTD9.66%, 2013 Forecast 3.50%, Overweight), Non Agency RMBS ( YTD 37.34%, 2013 Forecast 8%9%, Overweight). Emerging Market breakdown: Ex ternal Debt (YTD 17.44%, 2013 Forecast 5%9%, Overweight), Local Debt ( YTD16.76%, 2013 Forecast 8% 12% Overweight), Corporate (Y TD 16.74%, 2013 Forecast 6% 9%, Overweight). Yield to worst. Yield to maturity.1 We continue to view TIPS favorably as an alternative to nominal Treasury exposure in a por tfolio.The respective indexes are listed at the back of this repor t. Inflation protected position represents outr ight positioning.


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[ 2 ] J a n u a r y F i x e d i n c O m e m a r k e T s T r a T e g y

Wot gt Foo a mo of

m Fvot Th (o) fo 2013This ears outlook piece o reatest hits suarizes the

investent outlook or 2013. Our lea thee hihlihts the

short an lon run aspects o the interest rate outlook.

Over the lon run, toas low interest rates lock in neative

returns ater inlation, oolin investors epectin air

returns in ie incoe. However, the short-run returnoutlook epens criticall on the net phase o iscal polic

uncertaint an econoic resilience. Havin achieve the

last inute eal to avoi the worst case scenario, the iscal

cli outcoe postpones ost o the iicult ecisions into

the ebt ceilin ebate. Whether those outcoes erail the

econoic recover will eterine whether rates en up hiher

or lower b ears en an whether our epectations or oest

increases in interest rates in 2013 taretin 2.25% or the

10 eareans we en up oole aain. Fiure 1 suarizes

our reatest hits o investent thees or 2013.

Th O e of F io ivt Ov

Fie incoe returns beneite ro everthin oin riht

in 2012. The atpical situation o eclinin interest rates an

eclinin creit risks le to an ine return or core ie

incoe o 4.2% but provie the averae bon un anaer

the opportunit to nearl ouble that return to just over 8%.1

Unlike past ears, however, achievin those returns require

siniicant rit ro the benchark, unerweihtin

interest rate risk an overweihtin creit risk. While the

averae bon un elivere those nearhistoric averae

core ie incoe returns in 2012, achievin siilar results

in 2013 will be uch harer. Investors shoul ajust their

ie incoe return epectations lower or 2013 uch

lower. For 2013, we epect core ie incoe benchark

returns onl in the reion o 1-2% an siilar anaer rit

ro the benchark in 2013 iplies returns onl in the 2-3%

reion or the averae bon un.

But siniicant opportunities still eist or investors that

throw o the ol era o ie incoeinvestents tie

to the benchark an to unerperorin interest rate

risk sensitive asset classes an ebrace New Worl

investent strateies that utilize a ore leible approach.

The Bon market Suar hihlihts our crosssector

ie incoe return projections alon with our lonerter

recoenations or 2013 as well as last ears perorance

an current iels.

Ol era strateies in ie incoe tpicall contain too

uch uration eposure throuh overconcentration in

Treasur, Aenc an mBS sectorssectors that likel

unerperor in 2013. In contrast, overweihtin creit

seents o ie incoe in areas such as hih iel, bankloans, eerin arkets, unicipals an creit portions

o the ortae arket (non-Aenc mBS) oer the

scope or better returns in 2013.

Th e of e

Two ke eatures eine the ol era o ie incoe investin:

iel an uration. Fiure 2 on the net pae, however, hihlihts

how these two ke eatures o this era no loner eist: (i)

iels toa stan below the level o inlation an (ii) interest

rates toa have less roo to rop. The ke eatures o the

ol era iels above the level o inlation an secularl

eclinin interest rates create returns that over the past30 ears averae 8%near equit like averae returns

with hal the volatilit o the stock arket.

1Asset-weighted average return of Mornings tar Intermediate bond f und uni verse.

Figure 1: 2013 inVesTmenT THemesand recOmmendaTiOns

Th roto

Wont get

Foole Aain

Reuce interest rate-sensitive seents o fe incoe

(lon uration, treasur, aenc/aenc mBS) in avor o

hiher creit risk seents o fe incoe: corporate, hih

iel, unicipal ebt, eerin arkets an the creit

seents o the ortae arkets.

Like a

Rollin Loan

Sta overweiht hih iel or incoe, but increase bank

loan allocations.

The Wa

We Were

Stocks beat bons, an creit beats interest rate risks.

Increase creit risk an reuce interest rate risk in

bon portolios.

movin Out A housin recover thee avors bank bons in investentrae an creit areas o the ortae arket, thouh

outperorance o both is liite relative to past ears.

goin urther own the capital structure in banks also

akes sense as bank equities have sinifcantl lae

other housin recover thee sectors (e.. hoebuiler

stocks) suestin banks can outperor hoebuilers

in 2013.

How Will

I Know?

Stabilizin China rowth in 2013 supports the outlook

or eerin arkets. Overweiht eerin arket bons

(har currenc soverein an creit as well as local

currenc) as positive unaentals an stron investor

ean or iel continues to lea to outperorance

in the sector.

Turnin

Japanese

Reation polic in Japan leas to a lower en in 2013. Bon

iels however likel reain constraine as polic intervention

takes on a ore repressive nature liitin the scope o

iel increases. Successul en evaluation likel benefts

stocks as well, thouh look or unerperorance in Q1

on consoliation o recent ains.


3/8

W O n T g e T F O O l e d a g a i n a n d m O r e O F m y F a V O r i T e T H e m e ( s O n g s ) F O r 2 0 1 3 [ 3 ]

2 Precisely, under unchanged interest rate scena rio, the aggregate index returns approximately 1.75%, 25 basis points below our expectation for 2% realized inflation in 2013, leading toa 25 basis point loss after inflation.

Figure 2: Treasury yields Vs. realizedinFlaTiOn raTes

Figure 3: mOVing FrOm Old era TOneW WOrld inVesTing

Wo to th nw Wo of F roToas New Worl o ie incoe oers nowhere near

that potential or return in 2013. The Feeral Reserves zero

interest rate polic in place since the 2008 crisis has le to a

raatic collapse in the abilit to enerate incoe ro ol

era ie incoe investent approaches. An the epansion

o the Fes balance sheet to purchase Treasur an mBS

securities introuce a eree o inancial repression to

the inancial arkets not seen since the 1940s. yiels so low

that the no loner copensate or inlation is the hallark

o such an iplicit polic choice. But the outcoe or ie

incoe investors is never oo: the prospect o risin

inlation ro such policies as occurre in the 40s an

50s leas to neative ie incoe returns ater inlation

(-3.5% in the 40s an -1% in the 50s). Furtherore, the

prospect or liite interest rate eclines but uch larer

increases introuces a larer ownsie return proile than

upsie potential. But heres the real kicker: even i interest

rates o nothin at all in 2013, traitional ol era ie

incoe investentsthat is, investents that concentrate

allocation to interest rate sensitive ie incoe sectors

will suer neative returns ater inlation.2

so wht o i o wth o?

At the portolio level, investors nee to look beon the era

o traitional core ie incoe investin. Where a tpical

ol era ie incoe portolio hel two-thirs interest rate

risk an onl one-thir creit risk, toorrows New Worl

strate shoul reverse those weihtins, holin two-thirs

creit risk an onl one-thir interest rate risk.

An while we reail acknowlee that such a shit increases

the aount o equit risk present in the ie incoe portolio,

as we hihlihte earlier, ost tpical core anaers are

alrea utilizin such a strate so that ost ol era

allocations alrea ehibit ore equit correlation than the

have in the past. Allocatin awa ro these traitional

strateies towars one o eplicit asset allocation can better

anae the equit risk lurkin in the ie incoe portolio.

As we etail ore below, in increasin creit risk eposures,

consier loatin rate bank loans as a iversiier ro hih iel

strateies that have worke well in the past but show ore

liite prospects in 2013. Consier ain eerin arket

alternatives an not just in sovereins but corporate

eposures as well. An consier leible ie incoebut

where the strate has abilit to better anae those risks

throuh its leible approach an broaer risk itiation

tool kit. Such leible, unconstraine, or opportunistic

strateies anae the creit an interest rate risks with

anaeent stles that are not tie to the benchark

or to the past strateies that increasinl wont work intoorrows ie incoe environent.

Th 2013 itt rt Otoo o

Wot gt Foo a?Our outlook or interest rates in 2013 pivots on the outcoe

o the looin ebt ceilin ebate, in which we continue toanticipate an avoiance o at least the worst case scenario

that replas the 2011 ebacle. This outcoe woul support

a raual rise in rates throuh the coin ear to 2.25% or

the 10-ear US Treasur. Alon the wa, the looin ebt

Source: Bloomberg.

-5

15

10

5

0

20%

1963 1973 1983 1993 2003 2012

RATIO

10-Year Treasury Yield Realized Inflation

OLD ERA ALLOCATION NEW WORLD ALLOCATION

Interest Rate Risk Credit Ri sk

2/3 2/3INTEREST

RATE RISK

CREDIT

RISK

adJusTing duraTiOn/yield mismaTcH

Redce Dration | Floatin Rate, Lon/Short, Fleible/Strateic

Increase yield | Hih yiel, Floatin Rate, Fleible/Strateic


4/8


ceilin ebate alon with the host o uncertainties will ean

a consierable rane in rates potentiall as lare as 50 basis

points on either sie o that 2.25% orecast. Continue

Fe polic accooation likel liits the scope or ore

increases than that in 2013. However, were policakers

to ail to coe to an areeent on the postpone spenin

cuts necessar to strike areeent on raisin the ebt

ceilin, it is likel that interest rates woul reain low or

loner ai the etene econoic uncertaint. On the

other han, the outlook or inlation appears ore clearl

benin, ecluin the volatile oo an ener coponents.

We epect inlation will hol stea at least or now iven

the lack o wae an beneit pressures an the subue

rowth environent.

Ultiatel, we believe the iscal polic neotiations will

be conucte without peranentl aain near ter

econoic conience but reain oubtul on eaninul

iscal polic reor to aress the lon run issues, leavin

our base case as 2% econoic rowth but with risks to the

upsie. Cobine with the reuction in risks o eurozonebreakup an a China econoic har lanin, the liht-

to-saet into Treasuries shoul subsie in 2013, leain

to our view o oest increases in interest rates. However,

ai the continuin subpar recover an weak job arket,

the Feeral Reserve will aintain its latest or o open

ene quantitative easin that supports inancial arket

asset inlation an continue low interest rates.

Finall, we hihliht the risk to our outlook or oestl

increasin rates. For the past several ears, epectations

or risin rates have been ashe as eternal risks le to

heihtene econoic uncertaint, increase ean orTreasuries, an ore Feeral Reserve bon buin. To be

sure, our orecast or hiher rates in 2013 is ore oest

than in the past relectin these concerns. yet rates coul

en up even lower in 2013 uner the alternative scenarios

o sel-inlicte iscal polic aae, or i et another bout

o eternal risk whether ro Europe, the mile or Far

East or other hotspots were to aain arise.

T Th O r o Th H

In toas New Worl o ie incoe the ol rules are

turne upsie own. Financial arkets react ore to

the econos perorance or its ipact on onetarpolic epectations than to onetar polics ipact

on the econo. Fiure 4 above hihlihts how the

relationship between econoic unaentals an interest

rates has broken own urin the latest iteration o

Fe onetar polic.

In the current onetar polic environent, Fe polic

reacts in a skewe ashion: on the one han, it is cautious

towars sinalin risin rates on an perceive teporar

econoic strenthenin. On the other han, it is aressive

at eetin epectations or ever-increasin aounts o polic

accooation. This polic reaction has le to a one-wa

correlation between rates an unaentals: lower rowth

associate with eclinin rates but ore liite increases in

rates ro hiher rowth. Siilar to this tie last ear, the

ap between low rates an risin econoic rowth suests

hiher rates, et persistent polic accooation in eectsot inancial repression hols own those increases.

The prospects or a eaninul shit in housin (as we etail

below), an ore caution ro the Fe ro urtherin

unconventional polic at toas balance sheet size, suests

that 2013 coul see an iportant shit in the prospects o

uture policsinalin ovin the US ever so rauall towars

easin o the accooation. The liits o a still hihl

leverae econo (let alone a hihl levere overnent

sector) liit the scope o an such increases, an hence our

orecast or oest increases in rates in 2013. On the risk

sie stans the prospect that et aain econoic rowththat appears to be strenthenin at the en o one ear

onl to isappoint in the beinnin o the net. This ears

isappointent a et lie in the iscal ebate just past

as the ipact o the epirin paroll ta provisions plus

continue iscal uncertaint raise the risk o apenin

spenin ro both eclinin isposable incoe as well

as eclinin conience. Those scenarios reain a risk to

our otherwise constructive outlook on raual et oest

Figure 4: mind THe gap? relaTiOnsHipBeTWeen raTes and FundamenTalsBreaks dOWn in a Qe WOrld

Source: BlackRock, Bloomberg, Citigroup Research

-100

-150

100

50

0

-50

150

2

1.5

1

4

3.5

3

2.5

4.5

1/09 6/09 1/10 6/10 1/11 6/11 1/12 12/126/12

CITIGROUPECONOMICSURPRISEINDEX

US

10YINTERESTRATE

Citigroup Economic Surprise Index (LHS) 10-Year Interest Rate

Operationtwist66% Correlation

pre-Euro crisis,pre-twist, QE3

Correlation toimproving economicdata breaks down


5/8


stabilit in US econoic rowth leain to oest increases

in interest rates over the course o the ear.

l ro loHow oes it eel? The ouble iit returns o the hih iel

arket over the past ear elt prett oo. But lower startin

iels eans lowerin asset class return projections in 2013

to i to hih sinle iits. We sta overweiht hih iel as

those returns, while lower than in past ears are still attractive

or the eault risk that aple lobal liquiit keeps at ba in

2013. However we look to reuce risk in this incoe seent

o the portolio b shitin hih iel bon allocations into

bank loans that oer siilar iels but with lower risk.

Broal, toas treenousl accooative onetar

environent supports corporations access to ebt arkets

an reinancin options. That helps keep eault risk low, which

osets the risks o ownin creit instruents. We epect

eault rates to reain low even in a weak rowth environent.

Corporate eault risk is lessene as virtuall all hih iel

borrowers have access to the arket to reinance ebt, reuce

interest epense, eten aturities an better their ters.

Furtherore, an o the weakest copanies eaulte an

restructure or liquiate in the 20082009 inancial crisis,

leavin behin a arket with overall stroner balance sheets

enablin the reater abilit to weather an econoic ownturn.

That oesnt ean hih iel wont have its bouts o risk-o;

less cushion in the or o lower iels in 2013 eans a nee

to be ore tactical with the asset class than in past ears. Lower

startin iels an hiher startin prices eans lowerin asset

class return projections in 2013 ro the past ew ears o

ouble iit returns into the i to hih sinle iits or 2013.

As such, investors shoul consier iversiin their

eposures in hih iel to inclue loans an secure creit.

These oer iels at ore copellin valuations than tpical

hih iel bons. Overall, while likel eneratin lower

returns in 2013, the hih iel, loan an secure bon asset

classes still oer attractive iels in the contet o aple

lobal liquiit that keeps eault risk at ba in 2013.

Th W W WWhats too painul to reeber, we sipl choose to oret

An es, that is a Barbara Streisan reerence. At the root o

the last creit crisis stoo overl accooative onetar

polic uelin asset price bubbles. Have policakers learne

an lessons? Persistent accooative onetar polic

reains the ke eterinant o risk asset price perorance

in 2013: ore one printin eans ore asset price inlation.

That akes risk assets stocks an the ost creit

sensitive bons the best perorin asset classes in 2013.

Bo Bbb? no, Bo tht-Bbb t

An asset price bubble is when the epectation that the price

can onl o hiher ors the onl rationale or purchase.

Resiential real estate beore the crash, internet stocks inthe late 90s an ol toa all epict such characteristics.

But or ie incoe, in answerin the bon bubble question,

the ain otivation o investors or buin ie incoe is

the opposite o tpical bubbles: the ear o losin one

rather than the ree o potential proit has uele the historic

shit o assets into ie incoe. That akes i anthin bons

the anti-bubble: investors bu the because the epect

that the cannot o own. The risk however or investors in

2013 is that even with our outlook or onl oest increases

in interest rates, returns available in core ie incoe will

not keep up with inlation we epect to rane aroun 2% in

2013. An as the scenario table in Fiure 6 hihlihts, ratesat the hiher en o our rane a lea to neative returns

even beore consierin the ipact o inlation.

In an asset price bubble, it is leverae the willinness an

abilit to borrow onethat uels the price increases an

reinorces their ascent. Risin prices uel reater epectations

or risin prices. An that epectation creates ore

Figure 5: Hy spreads Vs. deFaulTs

1500

1000

500

0

2000

0

12

8

4

16%

1986 1990 1994 1 99 8 2 00 2 2 00 6 2 01 02012

SPREAD

-TO-WORST(BPS)

TRAILING12MONTHD

EFAULTRATE

High Yield Spread-to-Worst High Yield Default Rate

Source: Moodys, JP Morgan.

Source: BlackRock.

Figure 6: 2013 reTurn scenariOsin Fixed incOme

us 10 t B at

1.75% 1.70%

2.25% 0.72%

2.75% -0.40%


6/8


willinness an abilit to borrow aainst the risin value o the

asset. Creit uele bubbles are stronl reinorcin until

the ultiatel collapse uner the weiht o their own ebt.

In broa ters, such a scenario characterize the lea up

to the housin arket uele creit crisis o 2008. One ke

eature o that pre-crisis environent encourain the use o

leverae was onetar polic. In its response to the crash o

the previous bubble the tech stock bubble the Fe irstcut interest rates aressivel in 2001, then hel the polic

rate below the level o inlation ro 2002 throuh 2005. Low

interest rates create an incentive to borrow, but the size o

the incentive is relate to inlation: when inlation is hiher

than our interest rate inlation eectivel helps to pa o

the ebt. Toas polic environent o neative real interest

rates resebles that prior environent o 2002 to 2005 onl

its one lobal. Toa ever sinle ajor evelope central

bank runs neative real interest rates. An unlike in 2010 an

2011, in 2012 an 2013 eerin arkets are also runnin

ore accooative polic as oppose to tihtenin polic

akin the currenc outlook ore abiuous than in prior

perios o Fe quantitative easin.

Toether, this lobal polic accooation uels inlation

o a ierent sort, inlation in asset prices. That eatureeplains the isconnect between inancial asset price

perorance where US stocks increase ouble iits an

risk portions o ie incoe such as Hih yiel returne

nearl 16% while the econo barel rew above 2%. In a

worl o assive one creation ro lobal central banks,

the unaental river o asset prices is not unaentals

but the aount o one creation its rate o chane, the

lenth o tie it will be bein create an the creative ors

in which its act or proise takes place (the LTRO, the OmT,

the FLS, etc)*that eterines inancial arket prices

uch ore than the perorance o the econo.

The risk, o course, is to istake the recover in inancial

arket prices or sinalin the success o these polic

interventions in the real econo an oret the istortionssuch inancial arket behavior can have on the real econo

throuh the allocation o creit an the pricin o risk. In

toas unconventional onetar polic worl, its the ipact

o the econo on onetar polic rather than the other wa

roun that eterines asset prices. An in the lrics o the

son, But its the lauhter, that we reeber, when we

reeber, the wa we were.

mov OtO the baseent, that is; representin our housin recover

thee an a reat source o optiis to the econoic

outlook in 2013. O the ke chanes in the acro outlook or

2013, a einitive turn in the housin arket stans as one o

the ost iportant potential reasons to epect better than

epecte rowth in 2013. Housin an its collapse stoo at

the root o both the crisis an the slow rowth aterath

oin on over our ears. An the ailure o the Fes relation

polic as escribe above to irate successull into the

housin arket accounts or both the continue tepi recover

an the robust onetar polic response up to toas

unliite proise o one creation tere QE ininit.

Figure 7: mOneTary pOlicy FuelsasseT inFlaTiOn

1600

1200

800

400

2800

2100

1400

700

2000 3500

2007 2008 2009 2010 2011 2012

S&P500

FEDBALANCE

SHEET($BN)

Federal Reserve Balance Sheet ($BN, RHS) S&P 500 (LHS)

Source: Bloomberg, Federal Reserve

Figure 8: Banks lag HOmeBuilders OnHOusing recOVery

100

80

60

40

20

0

120

500

400

300

200

100

0

600

2008 2009 2010 2011 2012

HOMEBUILDERS(LHS)

BANK

(RHS)

Homebuilder (LHS) Banks (RHS)

Source: Bloomberg. Note Banks represented by KBW Bank index; Homebuilders by S&P500 Homebuilding Index.

* LTRO - Long-Term Refinancing Operations; OMT Outright Monetary Transactions; FLS Funding for Lending Scheme


7/8


To what en? To the recover in the job arket beore uelin

inlation hopes the Fe. The slow roa to that recover went

throuh the inabilit o the ortae arket to transit the

polic accooation into the housin arket: unintene

polic actions restraine the rowth o creit while persistent

weak hirin ro a lack o business conience restraine

ean as the kis in the baseent elae househol

oration ue to want o a job. Now it appears all o that a

be about to chane to the beneit o better than epecte

econoic rowth.

While we share these views, the trouble is so too oes

everone else. Housin recover-thee investent

strateies alrea outperore last ear. With so uch

hope or such a recover price into the arket, the risk

is isappointent in 2013, particularl in hoebuiler

stocks. However, other beneiciaries eist incluin bank

bons in the investent rae arket an creit areas o the

ortae arket thouh aittel with ore liite upsie

than last ear iven current prices. goin urther own the

capital structure in banks also akes sense as bank equitieshave siniicantl lae other housin recover thee

sectors (e.. hoebuilers as inicate in Fiure 8)

suestin banks can outperor hoebuilers in 2013.

How W i kow?Just trust our eelins When it coes to the ipact China

has on the lobal econoic outlook, probabl better to i

eeper. At the en o 2012, Chinas rowth slowown appears

to have stabilize on the successul application o its traitional

polic tool o rapin up inrastructure investent an easin

creit. However, the lonerrun outlook epens criticall on

the abilit o the new leaership to ipleent ke structural

reors. That abilit reains uncertain an with it a ore

uncertain loner run outlook or Chinas rowth. For 2013

however, China likel supports the lobal rowth outlook,

uelin continue stron eerin arket perorance.

a (io p) l kq

The potential or political consierations to ipact the

calculation o Chinese econoic statistics leas to the

questionin o the accurac o Chinas oicial econoic

releases. These concerns were valiate quite unintentionall

in a WikiLeaks eo ro 2007. When he was part leaer

o northeastern Liao Nin province, Chinas incoin preier

Li Keqian share with then-U.S. Abassoor to China Clark

Rant that he int rel on provincial gdP ata because the

were an-ae an or reerence onl. Instea, he ocuse

on just three ata points to evaluate Liao Nins econo:

electricit consuption, rail caro volue an bank lenin.

These three ata points suarize the input (electricit

consuption), output (rail caro) an creit (bank lenin)

o an econo, especiall one in which the share o

anuacturin is nearl 50%. Fiure 9 shows the Li Keqian

Ine relative to oicial gdP.

given this ine oesnt capture uch in service sectors, it is

ore volatile than gdP rowth. As we can see, startin ro

beinnin o 2012, the ine starte a broa ecline beore

it reboune in ourth quarter, helpe b increase in ie

investent an easin onetar polic. These two polic leversrepresent the traitional polic accooation levers use

b China polic akers to stiulate (an restrain) the econo.

Little b wa o transorational polic has been accoplishe

in that ost o the econo is still heavil eare towars

prouction, investent an eports an a strikinl low (b

historical an eoraphical coparison) level o oestic

consuption. Fiure 9 hihlihts that these traitional polic

levers suest better econoic perorance ro China in 2013.

Loner ter, the abilit to sustain this level o rowth hines

on the aoption an successul ipleentation o critical

structural reors. For eaple, accorin to the China

Institute or Reor an developent, risin rates o

urbanization coul account or increasin consuption share

o gdP ro current levels aroun 35-40% to 55% over the

net ecae. Chinas successul transition to a consuption-riven econo hines on Chinas onoin reors in the

resient reistration sste, the inancial sste (interest

rate liberalization, echane rate liberalization an inancial

arket liberalization), an actor price liberalization (reovin

price controls both subsiies an caps). Ke to onitorin

proress alon these lines will be the National Peoples Conress

an Consultative conerences in march an the 3r Plenar

Figure 9: HOW Will i knOW? ask li keQiang

-5

20

15

10

5

0

25%

2004 2005 2007 2008 20092006 2010 2011 2012

REALGDPGROWTH(%)

Change in Li-Keqiang Index YoY(Electricity Consumption, Rail Cargo, Bank Loans)

GDP Growth Rate

Source: National Bureau of Statistics of China, Citi Research


8/8

The sector performance and yields listed are represented by, respectively: Barclays US High Yield Index, S&P Leveraged LoanIndex, Barclays US Securitized Ex-MBS Index, Barclays US Mortgage Backed Securities Index, Barclays US Corporate InvestmentGrade Index, Barclays Global Aggregate ex-USD Index, JP Morgan EMBI Global Diversified Index, Barclays US Inflation ProtectedSecurities Index and Barclays US Treasury Index. The reference indices are represented by the Barclays US Aggregate and theBarclays Municipal Bond Index.

Investment involves risk. The two main risks related to fixed income investing are interest rate risk and credit risk. Typically, wheninterest rates rise, there is a corresponding decline in the market value of bonds. Credit risk refers to the possibility that the issuerof the bond will not be able to make principal and interest payments. Investments in non-investment-grade debt securities(high yield or junk bonds) may be subject to greater market fluctuations and risk of default or loss of income and principal thansecurities in higher rating categories. International investing involves additional risks, including risks related to foreign currency,limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or otherdevelopments. These risks are magnified for investments in emerging/developing markets or smaller capital markets. Indexperformance is shown for illustrative purposes only. You cannot invest directly in an index.

The opinions expressed are those of BlackRock as of January 11, 2013, and may change as subsequent conditions vary. Information and opinions are derived from proprietary and nonproprietarysources deemed by BlackRock to be reliable. The information contained in this report is not necessarily all-inclusive and is not guaranteed as to accuracy. Past performance does not guaranteefuture results. There is no guarantee that any forecasts made will come to pass. This material does not constitute investment advice and is not intended as an endorsement of any specific investment.Investment involves risk. Reliance upon information in this report is at the sole discretion of the reader.

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2013 BlackRock, Inc. All Rights Reserved. BLACKROCK, BLACKROCK SOLUTIONS, iSHARES andSO WHAT DO I DO WITH MY MONEY are registered and unregistered trademarks of BlackRock, Inc.or its subsidiaries in the United St ates and elsewhere. All other trademarks are t hose of their respective owners.

Prepare b BlackRock Investents, LLC, eber FINRA.

Lit. No. ISG-0113 AC6470-0113 / USR-1354

Not FDIC Insured Ma Lose Vale No Bank Garantee

Vt www.bo.oFo to foto, o to bb to w t to th .

session o the 18th Part Conress in the Fall o 2013. For the

short ter, well watch both the oicial sector ata an Li

Keqians recoene sectors to answer How will I know?

T JOr shoul we sa Turnin Bernankese? Japan takes a pae

out o the Fe plabook an a inall successull relate.

Thouh now consensus viewpoints, a weaker en uels a

stroner Japan equit arket in 2013, however, we woul

look or soe pullback in the irst quarter.

While we woul be cautious about etrapolatin too uch o

the 2012 surprise stor into 2013, the broaer iplications o

a scenario o Japan relation nee to be consiere or the

outlook in 2013. For uch o the past 20 ears, lobal rowth

prospects have been hel back b the lost ecaes in Japan:

real rowth rates that barel notche above 2%. Lost in the

ocus o evelope arket rowth iiculties in the US an

eurozone an eerin arket rowth optiis stans the

lack o Japanese rowth. There is a ichoto between the

share Japan represents o the worl econo (just uner

10%) an its share o the worls econoic rowth (neative

in 2011). Even a oest shit in Japan rowth ro ore

aressive onetar polic hols the prospect or upsie

surprise in lobal rowth in 2013.

Whether the incoin Abe ainistration an the potential

chanes can eet the arkets epectations or currenc

weakness an relationar oestic onetar policreains to be seen. To be sure, prior bouts o Japan optiis

have been et with isappointent. However, takin a pae

out o the other evelope central bank policies o assive

one creation suests a ore siniicant epansionar

onetar polic in Japan a be on its wa alon with a

contribution to lobal liquiit an asset inlation that the

Fe an the ECB so ar have le.

Figure 10: Japan OuTlOOk Hinges OnreFlaTiOn OpTimism

11000

10000

9000

8000

90

85

80

75

70

12000 95

1/10 6/10 1/11 6/11 1/12 1/136/12

NIKKEIIN

DEX

JPY/

USDSPOT

Nikkei (L) JPY/USD (R)

Source: Bloomberg

Documents

2013 Fixed Income Strategy